Slideshare uses cookies to improve functionality and performance, and to provide you with relevant advertising. If you continue browsing the site, you agree to the use of cookies on this website. See our User Agreement and Privacy Policy.

Slideshare uses cookies to improve functionality and performance, and to provide you with relevant advertising. If you continue browsing the site, you agree to the use of cookies on this website. See our Privacy Policy and User Agreement for details.

4.
Motivation
GIIPS and the Eastern European BELL countries (Bulgaria, Estonia, Latvia,
Lithuania) experienced a sudden stop in private capital ﬂows during the
recent crisis.
Historically, the resulting adjustment pressure due to a sudden stop often
made countries devalue their currency; however, GIIPS countries were
members of currency union and each of the BELL countries kept the peg to
the Euro throughout the crisis.
Adjustment has taken place via internal devaluation, which is e.g. visible in
the development of unit labor cost (ULC) since the crisis (see e.g. Staehr,
2012 (Baltics), Blanchard et al., 2013 (Latvia)).
There are notable diﬀerences between the adjustment paths of GIIPS and
BELL countries.
Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 4 / 42

8.
Research questions
Is there a (signiﬁcant) diﬀerence between GIIPS and BELL countries
regarding the adjustment to recent sudden stops?
If so, is this diﬀerence related to membership in the currency union (Euro
Area)?
Identiﬁcation issue: separate country-speciﬁc factors (e.g. labor market
ﬂexibility, openness) from Euro Area membership.
Sectoral data will prove useful in this respect.
Given that the diﬀerences are not linked to currency per se (BELL pegged):
What is the role of access to liquidity provided by the ECB and rescue
packages?
Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 8 / 42

9.
Existing literature on economic adjustment since the crisis
Generally, our work relates to the literature on sudden stops and
macroeconomic adjustment (e.g. Calvo, 1998, Calvo and Mendoza, 1996,
2000).
A couple of papers with focus on EA have recently emerged.
Lindner (2011), Gros and Alcidi (2013), Hansson and Randveer (2013)
give an comprehensive overview on the diﬀerences in the adjustment paths in
GIIPS and Baltic/BELL countries.
consider key economic variables such as GDP, the current account,
consumption, and exports.
discuss the role of access to Eurosystem liquidity and rescue packages.
Tressel and Wang (2014)
argue that adjustment in current accounts in GIIPS countries partly due to
structural but mainly cyclical factors.
Kang and Shambaugh (2014)
directly compare GIIPS and Baltic countries.
ﬁnd that unit labor cost adjustment can to some extent be attributed to
productivity gains but was mainly due to falling employment.
Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 9 / 42

10.
Main contribution
We base the analysis of the adjustment in ULC on sectoral data.
In particular, nominal and real unit labor costs are considered.
As well as their components: (real/nominal) wages, prices, labor productivity.
We assume that adjustment pressure should be higher in sectors which
depend more strongly on external ﬁnance.
Our empirical speciﬁcation allows disentangling the eﬀect of Euro Area
membership from country-speciﬁc (demand) factors as well as sectoral shocks.
We relate the diﬀerence due to Euro Area membership to enhanced liquidity
provision by the ECB during the crisis (reﬂected in the built up of
comparatively large Target2 imbalances) and ﬁnancial assistance/rescue
packages during the crisis.
Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 10 / 42

17.
Reﬁning the empirics - Ingredient II: Dependence on
external ﬁnance (DEF)
Rationale: adjustment pressure after sudden stops is likely to be higher in
sectors which are more dependent on external ﬁnance.
Idea: measure for dependence on external ﬁnance (DEF) in the spirit of Rajan
and Zingales (1998). Link to capital ﬂows: Prasad et al. (2007).
However: no such measure is available for the NACE classiﬁcation on the
level of aggregation given in our data.
We propose two measures for sectoral dependence on external ﬁnance (DEF):
The aggregate growth rate of MFI loans in given sector pre crisis
2003q1-2008q3 (Source: ECB SDW). Only variation across sectors not
countries.
The fraction of ﬁrms in need for external loan ﬁnance pre-crisis (in 2007)
taken from the “Access to ﬁnance survey” conducted by Eurostat. Variation
across sectors and countries. However, smaller sample with fewer countries.
Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 17 / 42

30.
The eﬀect of currency union membership and the role of
central bank liquidity
The estimated parameters measure the eﬀect of being a GIIPS as opposed to
a BELL country beyond any impact of country-speciﬁc or industry-speciﬁc
demand factors or any other shocks in these dimensions.
We can therefore plausibly argue that the remaining eﬀect has to be due to
another diﬀerence between BELL and GIIPS countries, which is the
membership in the Euro Area.
This eﬀect does not capture a diﬀerence in currencies as the BELL countries
pegged their currency to the Euro and kept the peg throughout the observed
period. The relevant diﬀerence is rather one of access to central bank
liquidity.
Data on Target2 balances provide us with an adequate measure when and
to which extent banks in the Euro periphery have drawn on central bank
credit to substitute for dried up private capital inﬂows.
Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 30 / 42

41.
Concluding remarks
We identify the diﬀerential eﬀect of currency union membership on
adjustment in nominal and real sectoral unit labor to a sudden stop in private
capital ﬂows.
To shut down the currency devaluation channel, the empirical speciﬁcation
directly compares GIIPS and BELL countries. In addition, the sectoral
analysis allows separating the eﬀect from any country and sector speciﬁc
factors/shocks.
With respect to the eﬀect of currency union membership on adjustment in
real unit labor costs (RULC), we ﬁnd that
it is negative (i.e. unit labor costs reduced by less) for most periods, which
points towards a slowdown eﬀect.
it is economically signiﬁcant: up to 25% lower (cumulative) adjustment in
some periods (per one std. dev. higher DEF measure).
it is conditional on higher sectoral dependence on external ﬁnance, which is in
line with economic reasoning.
the conﬁdence bands are rather wide in the ﬂexible speciﬁcation, but it is
highly statistically signiﬁcant in simpler speciﬁcation.
it is robust to inclusion of other relevant variables such as the amount of
EU/IMF rescue funds.
Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 41 / 42

42.
Concluding remarks
We ﬁnd evidence that this eﬀect goes indeed beyond the common currency
as it can robustly be related to national central banks’ Target2 liabilities,
which reﬂect to which extent banks in the Euro periphery have substituted
dried up private capital inﬂows with central bank liquidity.
However, the eﬀect of currency union membership on adjustment appears to
be less obvious for nominal unit labor cost and labor productivity and does
not translate to sectoral price deﬂators.
Policy implication: General role of currency union in adjustment process after
sudden stop?
Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 42 / 42